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All the financial statements are essentially
historical documents. They report what has happened over a given period.
However, most users of annual accounts are worried about what will happen in
the future. Shareholders are worried about future earnings and dividends.
Creditors are concerned about the company’s future ability to repay its debt.
Managers are concerned about the company’s ability to fund future expansion.
Despite the fact that financial statements are historical documents, they can
still provide important information that will affect all of these concerns.

Accounting analysis involves careful
selection of accounting data for the purpose of predicting the financial health
of the company. This is done by examining trends in key financial data,
comparing financial data between companies and analyzing key ratios.

Managers are also very concerned about
the financial ratios. First, key ratios provide evidence of how well the
company and its business units are performing. Some of these ratios would
normally be used in a balanced scoreboard method. Specific ratios selected are
determined by the company’s policy. For example, companies that want to focus
on customer response may closely monitor inventory turnover rates. Since
executives must notify shareholders and may want to raise funds from outside
sources, managers must adhere to the ratios used by external inventories to
assess the firm’s investment capacity and creditworthiness.

Although accounting analysis is a very
useful tool, it has two limitations. These two constraints include comparing
financial data between companies and the need to look proportional. Comparing
one company to another can provide valuable clues to the financial health of an
organization. Unfortunately, the difference in accounting practices between
companies makes it difficult to compare companies & # 39; financial data.
For example, if one company evaluates its stock using the LIFO method and
another company with the average cost method, direct comparison of financial
data such as inventory valuation and cost of goods sold between the two
companies may be misleading. Several times sufficient data are presented in the
notes to the annual financial statements to recalculate data on a comparable
basis. Otherwise, the expert should consider the lack of comparability of the
data before drawing any clear conclusion. Nevertheless, even with this
limitation in mind, comparing key ratios with other companies and industry
averages often leads to further investigation.

An inexperienced expert may think that
proportions in themselves are sufficient as a basis for a judgment on the
future. Nothing could be further from the truth. Conclusions based on the
proportional analysis must be considered as preliminary. End ratios should not
be regarded as starting points, but should be regarded as starting points as
indications of what to pursue. They raise questions, but rarely answer
questions themselves. In addition to the ratios, other sources should be
analyzed to judge the future of an institution. Those experts should look at,
for example, industry developments, technological changes, changes in consumer
tastes, changes in broad economic factors and changes within the company
itself. A recent change in key management position, for example, could provide
a basis for optimizing the future, even if the company’s past performance may
have been moderate.

Few figures that appear in the
financial statements are very significant. There is a relationship between one
number and another and the amount and change of policy over time that are
important in accounting analysis. How does the analyst gain important
relationships? How does the analyst uncover important business developments and
changes? Three methods of analysis are widely used; dollars and percentage
changes in statements, statements of common size and recipes for key
figures .